Bank bail-out: Blow to investors as dividend payments suspended

The Government's bailout package will be a blow to millions of investors and
pension funds, relying on bank shares for dividend income.

Signing up: Most of Britain's biggest lenders will participate in the Government's rescue schemePhoto: REUTERS/PA/BLOOMBERG/GETTY/JULIAN SIMMONDS

By Ian Cowie, Personal Finance Editor

8:21PM BST 07 Oct 2008

The Royal Bank of Scotland, Lloyds TSB and HBOS have agreed to ditch their dividend payments as part of the bank bail-out plan. In return for the funding, the Government will receive preference shares, which pay a fixed rate of interest instead of a dividend. This interest has to be paid before other shareholders receive anything. Barclays has also agreed to scrap its final dividend for 2008 which will save the bank around £2bn.

More than 2m people are listed on the shareholders' roll at HBOS, for example. The terms of the bail-out deal will render double-digit yields listed for this bank and others in recent weeks meaningless because these dividends will not be paid.

While more attention is usually focused on share prices, dividends – the income most shares pay twice a year – provide a substantial portion of the total returns delivered to investors. That was why Gordon Brown's move to impose tax on pension funds' and charities' dividend income from their share portfolios in his first budget as Chancellor has raised about £5bn extra tax from these funds each year since then.

Before the announcement, Lloyds TSB – whose bid to take over HBOS awaits shareholder approval – appeared to be yielding nearly 14 per cent before basic rate tax, while HBOS posted a yield of nearly 20 per cent. These figures compared with an average yield for the FTSE 100 of less than 4.8 per cent – or the equivalent of a gross return of 6 per cent for basic rate taxpayers.

The announcements this summer by RBS and HBOS that they would not pay their dividends in cash but instead use their own shares to deliver 'scrip dividends' was widely seen as proof that both banks were running out of cash.

Market analysts, including veteran fund manager Anthony Bolton of Fidelity Investments, had warned that apparently high yields – that is, the dividend expressed as a percentage of share price – were a warning that these payouts might not be maintained. Now that risk has been demonstrated.

Because of the effect of compound interest, the effect on long-term investors could be worse than they expect. For example, Barclays Capital – a subsidiary of the high street bank – calculates that £100 invested in a basket of shares reflecting the composition of the London market at the end of the Second World War would have rolled up to about £4,500 in real terms (that is, after inflation is stripped out) if dividends were reinvested.

Without dividends, the same investment over more than the last 60 years would be worth less than £350.